Government bursts into activity as big-bang solution misfires

AnalysisThe terms of any deal with the ECB on bank debt are the critical element

Once all the key players in Ireland's EU-IMF bailout agreed to put the issue of the promissory note on the agenda well over a year ago, a deal of some sort was always going to happen at some point - organisations such as those involved in the talks do not agree to allow something on the agenda if they do not accept that there will be an outcome.

That is the (very old) good news.

Less welcome has been the understanding that a straight cut in the debt was/is never going to happen in the current context (writedowns and/or write-offs will happen only if Ireland goes the way of Greece).

The promissory note is a sovereign obligation voluntarily entered into by the Irish State. Not honouring it would be a sovereign default. The current administration has never countenanced a unilateral sovereign default.

But despite much talk, including from people who should know better, writing off debt is not the only way to make the State's debt burden much more manageable.

An example

To see why, imagine being offered a loan of €1 million. Most of us of modest means would recoil at the thought of accepting such an offer because it would mean joining the ranks of the highly indebted. In these times - of all times - being highly indebted is not a position in which most people are comfortable to be.

But if the person making the €1 million offer then adds that he does not need to be repaid for 50 years and that he will charge no interest on the loan, even the most prudent and borrowing-averse person would immediately accept that offer.

Inflation is among the main reasons why one would be mad to turn down the €1 million.

Just as today's money buys much less than it did half a century ago, it will (almost certainly) buy much less again in another 50 years' time. Assuming that prices rise by 2 per cent every year for the next half century, the loan is free cash worth €630,000 in today's money.

The point of all this is that debt is as much more about its terms and payback time frame as it is about the total amount borrowed. The terms of the new IOUs which will replace the promissory note are the key ingredient in the deal.

What is certain is that the total cost - in today's money - will be lower when accumulated interest and the effects of inflation are factored in. The big question is: by how much?

But even with a very good deal, it should be recalled that the Government's total debts stand at about €200 billiion. The promissory note accounts for only €30 billion of that.

A study published yesterday by the trade union-linked think tank NERI showed that even if the promissory note was to disappear entirely the effect would be for Ireland to go from being the fourth most indebted state among the EU 27 to the fifth most indebted.